Play SCTY Stock as It Heats Back Up

SolarCity's technical improvement calls for this call spread trade

Amid an otherwise uninspiring performance by the broader stock market Tuesday, solar stocks like SolarCity Corp (SCTY) were glowing. By day’s end, the Street’s most popular solar ETF — the Guggenheim Solar ETF (TAN) — had climbed more than 2.39% (SCTY stock itself was up just more than 1%). Not a bad showing compared to the S&P 500’s drop of 0.32%.

SCTY stock has become a favorite candidate for momentum traders this year thanks to its elevated volatility and massive upside explosion. Since the dawn of 2013, the solar energy provider has soared as much as 447%. Although SCTY stock experienced a notable pullback in November, it has since recovered and appears poised to revisit its peak in the coming months. Let’s head to the charts to highlight a few positive developments from the past few weeks.

During last month’s drop, SCTY stock fell beneath both the 20- and 50-day moving averages. While an occasional break of the 20-day MA is quite normal for most uptrending stocks, breaching the 50-day MA suggests a more significant deterioration in trend. Fortunately for SolarCity, the breakdown was quickly reversed. Fast-forward to today, and SCTY stock has climbed back above both averages.

Further buttressing the bullish case for SCTY stock is the bull flag that has formed during the past two weeks. A bull flag is a continuation pattern that usually resolves itself to the upside once the stock is ready to begin its next advance. Tuesday’s rally broke SCTY briefly out of the flag but quickly reversed. Had the breakout occurred on a more bullish day for the stock market at large, I suspect it would have stuck. Regardless, SCTY stock still looks good and additional upside appears likely.

After peaking at 95% prior to its November earnings announcement, the implied volatility of SolarCity options has fallen notably to the mid-60s. With IV now at the lower end of its 52-week range, option prices aren’t too expensive here.

Traders looking for a cheap, limited risk play for SCTY stock in the coming month could buy January 55-60 bull call spreads. Buy the Jan 55 call and sell the Jan 60 call for a net debit around $1.30. The risk is limited to the initial $1.30 and the reward is limited to the distance between strikes minus the net debit, or $3.70. At $1.30 to $3.70, the risk to reward is quite attractive. Should SCTY stock stage a strong breakout, the spread trade could gain in excess of a 250% return.

Of course, SCTY stock needs to rise above $60 by Jan expiration for you to capture the max gain, but a $7.50 move during the next month is certainly within the realm of possibility for such a volatile stock.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.